Hallonomics

Happy Halloween!

Tonight, after my daughters and their friends went trick or treating, and came back with nearly identical sets of candy (they went to the same houses, afterall), they sat down to trade. Their tastes were diverse enough that there was actually quite a lot of candy traded. I estimate that each girl traded over one-third of her original candy for something different. Some pieces were traded more than once.

At the end, each girl was far happier with her new set of candy. Each girl valued her new set of candy significantly more than the old set. It was fun watching seven and ten year olds using trade to create value out of thin air.

After her friends left, I mentioned this value creation to my ten year old daughter. Much to my amazement, her reply was, "yeah, I was thinking about that as we were doing it." I recently read her "The Invisible Heart: An Economic Romance" and apparently she really has grasped many of the ideas presented in that book.

I've been troubled by the complete lack of understanding of basic economic principles by most people in the world and one of my goals is to help people grasp at least some economic concepts.

At least I seem to be succeeding at home.

Is Saving Always Good?

There are those who have told me they are sure that saving money is unequivocally good and that the more we save the better, no matter what.

That's an interesting belief, but a quick thought experiment disproves this concept.

Let's say there is a country whose well developed economy is self-contained (i.e. no external trade), with steady GDP per capita growth, an adequate level of savings and investment, and fairly low unemployment. Let's say that suddenly everybody in this country decides to become absolutely as frugal as possible in order to save as much as possible. In other words, everybody minimizes the amount of food they buy (no more chocolate – the horrors, the horrors!), stops buying clothes, switches to walking or using mass-transit to get to work, stops spending money for movies, music, and other entertainment, moves to smaller apartments, does everything for themselves (no maids, gardeners, plumbers, etc.), and so forth. Let's say that on average people were able to cut consumption by 50% and everybody put the money they saved by cutting consumption in a bank.

Would this increased saving increase wealth? Would it increase well-being? Lastly, would the decreased consumption really increase savings?

The answer to all three of these questions is no. Why? Because after a certain point every dollar not spent on goods and services is a dollar that someone else doesn't get paid to produce those goods and services. Those dollars that people aren't getting paid to produce goods and services aggregate into lost jobs. People without jobs have limited income (if any) and usually can't save much. Furthermore, because demand for goods and services has been drastically reduced, investment in capital equipment to produce those goods and services will be slashed to nothing so even those employed producing capital equipment will lose their jobs.

If we all drastically reduced our spending tomorrow, it would be catastrophic for the economy. We would not be wealthier. On average, we would be much poorer. Instead of increasing savings, we would decrease our Gross Domestic Product.

Has this ever actually happened? As far as I know, no, not really, at least not in isolation, but there have been a number of occasions that have shown us a glimpse of this effect. The Great Depression was primarily caused by gross mishandling of the economy by Hoover and FDR, but the great reluctance of people to spend what money they had probably added to the problem. The Japanese are great savers (as individuals). Their economy has been having problems for a long time (decades now), and if they were unable to export, I think those problems might be catastrophic.

The problem is that saving doesn't stimulate demand and without sufficient demand, saving has very limited value (if any). Saving is only useful (in aggregate) when it can be used to make investments to boost production to meet demand more inexpensively. If there's no demand, no investment is needed and saving isn't useful. A balance is required between consumption (demand), production, and saving (investment). If that balance is not present, saving can be counterproductive.

Baghdad Vigilantes

For a very interesting and completely different perspective than anything else I've read on what's going in in Iraq, I highly recommend the TCS Daily article "Baghdad Vigilantes and the Dark Side of Civil Society" by Frederick Turner.

The article argues that what we're seeing in Iraq is not a run up to civil war, but a vigilante clean up operation that's frequently preceded functioning democracies throughout modern history.

Wikipedia and the Speed of the Internet

Scott Adams, the cartoonist/humorist who created the Dilbert comic strip and has written numerous books, has a condition called Spasmodic Dysphonia. This condition prevents him from normal speaking. He could speak in public and he could sing, but he couldn't speak normally.

He has a blog, and in today's post (October 24, 2006) on that blog, he writes: "I asked my doctor – a specialist for this condition – how many people have ever gotten better. Answer: zero." Bummer!

But there's good news. Scott goes on to write in the same post that "The day before yesterday, while helping on a homework assignment, I noticed I could speak perfectly in rhyme... I still don’t know if this is permanent. But I do know that for one day I got to speak normally."

Congrats to Scott.

However, this post isn't really about Scott and Spasmodic Dysphonia. It's about the propagation of information on the Internet. Only "the day before yesterday" (October 22, 2006) he discovered a possible path to a cure, the first person ever to do so (and reveal it publicly). Within two days, on October 24, Wikipedia has this information incorporated in its entry on Spasmodic Dysphonia within a few hours of when Scott first published the information on his blog:

There is currently no cure for spasmodic dysphonia. [...]

Scott Adams, the creator of the famous cartoon Dilbert, has had Spasmodic dysphonia up till mid-October, 2006. He developed a method to work around the disorder and has been able to speak normally since. Full story on his weblog [1], no scientific proof yet.

It's amazing to me that an encyclopedia can objectively incorporate information that's just hours old. I've heard a lot of complaints of the objectivity of articles in Wikipedia, but I've found that as long as you discount articles addressing contentious issues (such as Evolution, Religion, etc.), it's stunningly accurate and stunningly up-to-date.

This sort of example has convinced me that some time in the next twenty to fifty years, the Mainstream Media (MSM), especially of the print variety, will cease to exist (or exist just as a novelty). I don't usually make this opinion of mine public because most people just laugh, but the speed of the Internet and the humans monitoring it are something that I don't think the MSM can compete with.

An encyclopedia with information that is never more than a few hours old. Amazing!

Thou Shalt Not Steal

You're at the library, between the rows and rows of books, and at one of the study tables you see someone studying. Except he's not. He's actually asleep. Sound asleep. In fact, he's snoring - not too loudly, but every indication is that he's in a very, very deep sleep.

Sitting next to him on the table is $100 in cash. Nobody else can see you, the sleeping person, or the money.

Would you take the money?

I'd bet that for virtually everyone reading this blog post (all six of you) or even anyone who would ever read a blog such as this one, the answer is no. The answer is no whether rich or poor, theist or atheist, male or female. In fact, I'd also bet that taking the money wouldn't even cross most of our minds in the first place. By not taking the money, we're essentially following the "thou shalt not steal" commandment, whether or not we directly subscribe to the religious version of it.

That's important because following "thou shalt not steal" coupled with the commandment about not coveting thy neighbors stuff forms the basis of western society's property rights. Property rights have enabled prosperity on a scale unimaginable when these commandments first evolved. On the other hand, communists threw out these commandments and ushered in an era of misery on a scale also unprecedented in human history.

For society as a whole, I believe it's incredibly important that these commandments are followed in aggregate, most of the time. For society as a whole, it's a rational thing to do. But it's much less clear that it's rational for a given individual.

For theists, at least of the Judeo-Christian heritage, it's perfectly rational not to take it. After all, God is always watching, and come judgment day, stealing $100 is just not worth it.

But for materialists? It's seems quite irrational to leave the money sitting there. Yet they won't take the money either. Why?

It can't be a directly genetic phenomenon. If it was, there wouldn't be a commandment about stealing. After all, there aren't any commandments like "Thou shalt breathe" or "Thou shalt lust after every pretty girl who walks by". If it's a natural behavior (or lack of behavior), God doesn't need to command it. Also, the soviets were able to toss out the commandments regarding stealing and coveting in one fell swoop with a large segment of the population going along with it.

It also can't be inherent respect for the laws of man. I'm sure y'all have exceeded the speed limit purposely and rolled through at least a few stop signs. Perhaps there was a little recreational drug use in college or maybe you pushed the legal limit of drinking while driving. I suspect that most of us who wouldn't dream of stealing the money in the library have broken numerous other laws of man. If the laws of man were written as commandments, they'd go something like "thou shall not speed unless you can get away with it or the penalty if caught isn't too big".

Even the golden rule doesn't provide a good explanation. One could always make the argument that if you're so stupid as to fall asleep with $100 out in the open in public, you would want someone to steal it to teach you a lesson. Besides, following the golden rule itself is irrational for a materialist (though pretending to follow it is not).

My explanation is that people are genetically predisposed to accept the mores of the greater culture even if they don't accept the beliefs. In this case, materialists accept the "thou shalt not steal" commandment even though they don't believe in God. I'm an agnostic who believes that it's extraordinarily unlikely that some supernatural deity has the inclination to track my every move (or any move for that matter) so I fall in the same boat as the materialists for the purpose of this discussion.

So I would leave the money on the table because I'm a stupid, irrational git. Fortunately for society in aggregate, most of us who are not religious are stupid, irrational gits. We have adopted the mores of the society around us even though it is irrational for us to do so given our beliefs.

Here's one interesting point. Our society is prosperous because most of us believe either in a God who has given commandments regarding property (which I think is most likely an irrational belief), or we've irrationally adopted the mores of those who do, or we've somehow otherwise irrationally adopted this set of mores. In any case, our society is prosperous because we are mostly all irrational one way or another. There has to be an irrational premise or conclusion somewhere in our chain of reasoning for there to be a prosperous society. Thank God for irrationality! Maybe I'll adopt that as my new motto!

I'd like to address one objection to the preceding statements immediately. You may argue that it's rational not to steal because if everybody did it, society would be less prosperous. True, but you would still be better off performing riskless thefts while pretending that you never did such things. Therefore, it's still irrational not to take the money in the library if you don't believe in God and the commandments.

So let's say we all became materialists tomorrow. Nobody thinks God's watching them anymore. Nobody thinks that the commandments are being enforced by God. The commandments are now just rules (or "guidelines" to paraphrase Captain Barbados in Pirates of the Caribbean) of man.

I suspect that we would then evolve towards the collectivists view of property rights (i.e. no property rights) and lots of theft. Already in the Netherlands, which is a fairly non-religious society, pretty much anything that isn't actually in your hand or carefully locked up disappears in fairly short order. Bicycle owners are instructed to use two different types of locks, each of which needs to simultaneously lock the bicycle to some stationary object. Even then, with as much bicycling as the Dutch do, you don't see very many nice bicycles.

This is one reason I have qualms about materialists wanting to weaken the religious infrastructure of the United States. I think our prosperity might depend on it. The irrational concept of a God watching us and potentially punishing us come judgment day if we violate His rules serves us well.

Of course the problem remains that many of God's rules are a bit out-of-date. It would be quite helpful if God would repeal the "thou shalt kill infidels" and a variety of other directives that some variants of religion have attributed to God. But we don't need to throw out the bearded baby with the bathwater. We just need to constantly lobby the spokespersons for God in their various religions to have a new vision about God's word. Indeed, for this one example, the spokepersons could just revert to boosting the priority of one of God's other commandments: "Thou shalt not kill."

You don't know Johan? - well you should

Writer and thinktank fellow Johan Norberg recently had this article published in the WSJ. He is a very articulate spokesman for the role of globalization and free market capitalism in raising untold numbers of people out of poverty.

We tend to take our opportunities for granted, but our ancestors could not have imagined what we now have. In the last 100 years, we have created more wealth than in the 100,000 years before that, and not because we work more.

The people we should thank are the innovators and entrepreneurs, the individuals who see new opportunities and risk exploring them -- the people who find new markets, create new products, think out new ways to handle commodities commercially, organize work in new ways, design new technology or transfer capital to more productive uses. The entrepreneur is an explorer, who ventures into uncharted territory and opens up the new routes along which we will all be traveling soon enough. Simply to look around is to understand that entrepreneurs have filled our lives with everyday miracles.

Entrepreneurs are serial problem-solvers who search out inefficiencies and find more practical ways of connecting possible supply with potential demand. In that way, they constantly revolutionize our economy, and have made it possible for average people today to live longer and healthier lives, with more access to technology than the kings had in previous generations.

Change is very disruptive. People want the benefits but not the cost of such disruption.

The ingratitude toward those who have given us almost everything seems strange. But perhaps there is a historical explanation. Wealth and innovation are recent phenomena. During about 3,999,800 of the perhaps 400 million years that hominians have existed, life has been a zero-sum game for most people.

Actually, with economic freedom and the industrial revolution innovation accelerated dramatically.

Today we live in a very different world. The system of reward in the free market is the complete opposite. You don't gain by stealing from others, but by giving them goods and services that they want. Our suspicion and our envy, however, remain the same. What was once a way to avoid being exploited by brutes, kings and knights now becomes a way of exploiting those who create new value.

So we are probably not well adapted to understand the modern economy. Whenever we see wealth we have gotten used to thinking that someone somewhere else has lost out. The history of socialism can be interpreted in this light. Marx said that the wealth of the capitalists came at the expense of the workers.

That the anticapitalists' particular concerns have been proven wrong again and again doesn't help for long, because soon they find a new excuse to condemn free markets. The latest variety is Marx on his head: He said that capitalism is bad because it actually creates poverty and slavery. Today, critics say that capitalism creates wealth and freedom -- but this is bad for well-being because we become stressed up, frustrated by the constant demand to choose, working too hard and consuming too much to keep up with the Joneses.

Don't expect the critics of capitalism to change their minds any time soon. As long as they don't believe in the creative ability of mankind or that the market is a plus-sum game, they will continue to think that someone, somewhere, is victimized whenever and wherever we see growth and innovation. Unless this disparagement of entrepreneurs is tamed, people will allow government, with its arsenal of taxes and regulations, to take their place.

You might also check the podcast linked to on this page. In it Norberg covers a lot of ground and demonstrates a tremendous range of knowledge including several little gems.

Ridiculous notions

In this recent post Bret bemoans the gullibility of many people. In earlier posts I commented upon the problem of ignorance especially in the realm of social science such as political economy. We are all limited by our beliefs and knowledge and our willingness to put forth efforts to alter and extend such. In light of these observations, this Julian Simon quote displayed at the FreedomKeys website, caught my attention.

"All of us necessarily hold many casual opinions that are ludicrously wrong simply because life is far too short for us to think through even a small fraction of the topics that we come across." -- Julian Simon

In my experience, neither intelligence nor formal education provide innoculation against this condition. We are all at risk of being trapped by things we parrot without understanding or beliefs, false premises or "facts" we use to construct a worldview. Very few people seem willing to put forth the effort required to chip away at their own ignorance.

Gullible

I remember watching the movie "The Wizard of Oz" when I was five years old and being so terrified of the wicked witch of the west that I don't think I fell asleep at all that night. She was the very embodiment of evil and wickedness that preys on the fears in a young child's mind.

I was thus quite surprised while in New York last week to learn from the Broadway play "Wicked" that the witch really was nothing more than a misunderstood and almost cuddly animal rights activist whose only crime was speaking truth to power. Indeed, it was truly impressive how the screenplay writers were able to revise the famous story only very slightly and paint a picture that was nearly exactly opposite of the one created by Frank Baum (author of "The Wizard of Oz").

It's a convincing picture too. Though I personally remember too many nightmares to be convinced, both of my daughters (ten and seven years old) now believe that the wicked witch is actually good, the good witch of the north (Glinda) is actually suspect, and the wizard is actually as evil as they come (far worse than the mere humbug that Baum created). The fact that this witch can really sing helps make her seem less wicked, but still, how can my children be so gullible?

Ahhh, but then I think of adults and politics (and other topics) where gullibility seems to know no limits and then I can forgive my kids. My eyes have certainly been opened to how effective a little spin can be. Indeed, the "Wicked" screenplay writers would do quite well to write for politicians who often seem to try and tell me that west is north, green is white, and wicked is good.

The Search for Dark Matter

You might guess from the title that this post is about physics and the universe. It turns out you'd be wrong. As you'll see, it's actually a post about trade.

If governments don't meddle, trade imbalances are usually nearly instantly eliminated by changes in exchange rates caused by market forces. In fact, if governments don't meddle, it's almost (but not quite) safe to say that there is no such thing as a trade imbalance. The exchange rate immediately finds the point that balances trade.

That's not to say that a country can't be a net importer of goods. But if it is, it has to, by definition, be a net exporter of investment, where foreign entities have created such a demand for that investment that the country has little choice but to be a net importer of goods. Another way of saying this is that a trade deficit equals an investment surplus. Generally, a small investment surplus is a good thing.

The United States currently has quite a large trade deficit/investment surplus. Around 7% of GDP, it's so large that it's hard to believe that there's not some sort of government meddling or trade imbalance. Any simple model would show that this level of investment surplus is not sustainable and is likely to have an unhappy ending.

But, as is often the case, the simple models may be, well, simply too simple. Ricardo Hausmann and Federic Sturzenegger from the Kennedy School of Government at Harvard University have come up with an explanation for the current situation which looks quite plausible to me. They believe it has to do "Dark Matter":

Let's look at some more facts. The Bureau of Economic Analysis (BEA) indicates that in 1980 the US had about 365 billion dollars of net foreign assets (that is the difference between the foreign assets owned abroad and the local assets owned by foreigners). These assets rendered a net return of about 30 billion dollars. Between 1980 and 2004, the US accumulated a current account deficit of 4.5 trillion dollars. You would expect the net foreign assets of the US to fall by that amount, to say, minus 4.1 trillion. If it paid 5 percent on that debt, the net return on its financial position should have moved from a surplus of 30 billion in 1982 to minus 210 billion dollars a year in 2004. Right? After all, debtors need to service their debt.

So let's look at how much is the actual return on the US net financial position. The number for 2004 is, yes, you've guessed it, still a positive 30 billion, just like in 1982! The US has spent 4.5 trillion dollars more than it has earned (which is what the cumulative current account deficit implies) for free! [...]

There is a large difference between our view of the US as a net creditor with assets of about 600 billion US dollars and BEA's view of the US as a net debtor with total net debt of 2.5 trillion. We call the difference between these two equally arbitrary estimates dark matter, because it corresponds to assets that we know exist, since they generate revenue but cannot be seen (or, better said, cannot be properly measured). The name is taken from a term used in physics to account for the fact that the world is more stable than you would think if it were held together only by the gravity emanating from visible matter. In our measure the US owns about 3.1 trillion of unaccounted net foreign assets. This is big. Before analyzing where this comes from, we may point out that no methodological minutiae will reconcile the facts with the statistics. We can discuss the numbers but we cannot contest the existence of dark matter.

The bottom line is that the measuring the current account is an act of accounting. Accounting has rules that are designed to be logical and consistent. Unfortunately, the rules don't always give perfect insight into what's actually going on. That lack of insight is Dark Matter. Here is one example of dark matter given by the authors:

Imagine the construction of EuroDisney at the cost of 100 million (the numbers are imaginary). Imagine also, for the sake of the argument that these resources were borrowed abroad at, say, a 5% rate of return. Once EuroDisney is in operation it yields 20 cents on the dollar. The investment generates a net income flow of 15 cents on the dollar but the BEA would say that the net foreign assets position would be equal to zero. We would say that EuroDisney in reality is not worth 100 million (what BEA would value it) but four times that (the capitalized value at our 5% rate of the 20 million per year that it earns). BEA is missing this and therefore grossly understates net assets. Why can EuroDisney earn such a return? Because the investment comes with a substantial amount of know-how, brand recognition, expertise, research and development and also with our good friends Mickey and Donald. This know-how is a source of dark matter. It explains why the US can earn more on its assets than it pays on its liabilities and why foreigners cannot do the same. We would say that the US exported 300 million in dark matter and is making a 5 percent return on it. The point is that in the accounting of FDI [Foreign Direct Investment], the know-how that makes investments particularly productive is poorly accounted for.

There are other examples as well given in the paper, but they all involve accounting arcana. It's not a bad read if you're so inclined, but I won't get into it here. The paper ends by trying to answer the question "Can dark matter be trusted?":

In a nut shell our story is very simple. The income generated by a country's financial position is a good measure of the true value of its assets. Once assets are valued accordingly, the US appears to be a net creditor, not a net debtor and its net foreign asset position appears to have been fairly stable over the last 20 years. The bulk of the difference with the official story comes from the unaccounted export of knowhow carried out by US corporations through their investments abroad, explaining why the US appears to be a consistently smarter investor, making more money on its assets than it pays on its liabilities and why the rest of the world cannot wise up. In addition, the value of this dark matter seems to be rather stable, indicating that they are likely to continue to compensate for the measured trade deficit.

Globalization has made the flows of dark matter a very significant part of the story and the traditional measures of current account balances paint a very distorted picture of reality. In particular, it points towards imbalances that are not really there, making analysts predict crises that, for good reason, remain elusive.

Currency traders seem to agree. I believe that's why, with fairly minimal government meddling, the exchange rates are remarkably constant in the face of supposedly huge trade deficits (investment surpluses). Those deficits are an illusion and the market knows it.